Reverse mortgages are loans available for people who are 62 or older that allow them to tap their home equity while still residing in their homes and without having to make regular loan payments.
In a reverse mortgage, the lender gives money to the homeowner as either a lump sum, fixed regular payment, or a line of credit based upon the value of their home equity, current interest rates, and the homeowner’s age. Unlike most traditional loans, when a homeowner takes out a reverse mortgage, he or she is not required to make monthly loan payments to the lender. Instead the outstanding loan balance is paid when the homeowner ceases to use the home as his or her principal residence, usually after the homeowner passes away, moves into a long-term care residence, or sells the house.
The three different types of reverse mortgages are home equity conversion mortgages, proprietary reverse mortgages and single-purpose reverse mortgages.
Home Equity Conversion Mortgage
A home equity conversion mortgage (HECM) is the most common type of reverse mortgage. Such mortgages are insured by the Federal Housing Administration (FHA). HECMs are typically more expensive than traditional home mortgages due to various costs and fees. It is the most common reverse mortgage because there are no income limitations, medical qualifications, or restrictions on how the loan proceeds may be used. In addition, the HECM is non-recourse. If the final loan balance exceeds the sale proceeds of the home, neither the homeowner nor his estate or heirs are liable to make up the difference. The federal government reimburses the lender for the difference.
How much an individual can borrow with HECMs depends on several factors:
Home equity conversion mortgages have no specific income limitations; however, a lender must conduct a financial assessment of a potential borrower before approving a loan. A financial assessment determines whether the individual will be able to maintain the home, including paying taxes and insurance, for the life of the loan. Depending on the situation, the lender might specify that a portion of the loan proceeds be used to pay bills, taxes and insurance.
Proprietary Reverse Mortgage
Proprietary reverse mortgages are reverse mortgages that are made outside of the program for FHA-insurd HECMs. The private loans don’t carry the federal insurance and most often are used on homes with equity that exceeds the maximum allowed under the FHA program. The loans also might carry lower fees than the HECMs, partly because the FHA insurance premiums aren’t charged. Proprietary reverse mortgage lenders may charge higher interest rates and lend a lower percentage of the home’s equity because they aren’t backed by the federal insurance.
As of January 2018, the maximum amount of equity that could be used to determine the amount of a HECM was the lesser of the home’s appraised value or $679,650. Each lender determines its limits for proprietary reverse mortgages. The only true limit to a proprietary loan is the amount of risk the lender is willing to take. Similar to HECMs, the proceeds from a proprietary reverse mortgage can be used for anything. A proprietary reverse mortgage also does not restrict the amount of money that homeowners can receive in the first year of the loan.
Single-Purpose Reverse Mortgage
A single-purpose reverse mortgage is the least expensive of the three. Single-purpose reverse mortgages are offered by state, local and nonprofit agencies. With this type of reverse mortgage, the agency specifies the purpose of the reverse mortgage and states the loan proceeds cannot be used for anything else. For example, the lender may specify that the loan can only be used for property taxes, mortgage insurance and home repairs. Like all other reverse mortgages, a single-purpose reverse mortgage does not have to be repaid until the homeowner dies or moves from the mortgaged home. The mortgage also might become due if the homeowner fails to maintain homeowner’s insurance on the property, pay taxes, or if the government takes control of the property.
Homeowners may have a harder time finding a lender for single-purpose reverse mortgages since most are issued by government agencies or non-profit organizations. The loans usually are restricted to borrowers with limited incomes and net worth.
The three different types of reverse mortgages each have different characteristics and fill different needs. Anyone considering a reverse mortgage should shop around with different lenders and consider consulting a financial advisor with an expertise in reverse mortgages.
Special thanks in preparing this summary of “What are the Different Types of Reverse Mortgages?” go to Bob Carlson, editor of the Retirement Watch financial advisory service and chairman of the Board of Trustees of Virginia’s Fairfax County Employees’ Retirement System with more than $4 billion in assets.
Jaxon Kim is an editorial intern with Eagle Financial Publications.